Investors should consider thematic exchange-traded funds now.
A pullback could occur in the fourth quarter as the stock market’s recent sell-offs, lower bond yields and decline in gross domestic product are facing additional headwinds from growing uncertainty caused by contentious negotiations over the next fiscal stimulus package, the upcoming U.S. election and the pandemic. An increase in volatility could also occur in the near term, and investors should diversify their portfolio with thematic exchange-traded funds. Sector performance will be less definitive now compared to 2021 when there is more data, says Jodie Gunzberg, managing director, chief investment strategist at Morgan Stanley, Wealth Management Institutional. “Inflationary pressure is building, supported not only from the recession and stimulus but from the pressures that were in place before the pandemic like populism, nationalism, deglobalization and a sign that the U.S. dollar may either lose or have to share its reserve currency status,” she says. Here are six thematic ETFs to consider.
Health Care Select Sector SPDR Fund (ticker: XLV)
The Health Care Select Sector SPDR Fund has more than $24 billion in assets under management and holds about 60 total stocks, including health care conglomerate Johnson & Johnson (JNJ), insurance giant UnitedHealth Group (UNH) and pharma giant Merck (MRK). XLV has a low expense ratio of 0.13%, a dividend yield of 1.55% and a 10-year performance of 15.29%. While the health care sector is “most likely to be impacted by the politics and the Supreme Court vacancy given considerations around the Affordable Care Act, it is a relatively favorable sector,” Gunzberg says.
Invesco Water Resources ETF (PHO)
The Invesco Water Resources ETF provides exposure to the clean water sector and invests in 37 companies. PHO is based on the Nasdaq OMX US Water Index that is focused on U.S.-based companies that create products designed to conserve and purify water for homes, industries and businesses. PHO has more than $1.1 billion in assets and has an expense ratio of 0.6%. Water is a commodity that can help diversify a portfolio since it’s not perfectly correlated with commodities or other assets as the futures market is not liquid enough to be included in the major commodity indexes, Gunzberg says.
Global X Cloud Computing ETF (CLOU)
The communication services and information technology sectors are two growth-oriented sectors that could help lead the market higher in the fourth quarter, says Todd Rosenbluth, head of ETF and mutual fund research at CFRA, a New York financial research company. “We think these sectors will continue to benefit from the slow reopening of the U.S. economy and a continuation of working from home environments,” he says. “Cloud computing ETFs, such as CLOU, First Trust Cloud Computing ETF (SKYY) and WisdomTree Cloud Computing Fund (WCLD) are some of the more popular ETFs tied to the technology sector.” The pandemic has increased the adoption of many technologies this year as more businesses had to adapt quickly, and data usage and storage continue to rise annually.
iShares U.S. Home Construction ETF (ITB)
The iShares U.S. Home Construction ETF can be a good asset to hold for a short-term or mid-term play since there is a supply constraint of new and existing homes in the U.S., says Daren Blonski, managing principal of Sonoma Wealth Advisors in California. The federal government is likely to pass another fiscal stimulus package, which could help potential homeowners who have increased their savings during the pandemic because they have moved out of cities, are living with their parents or lowered their expenditure levels while working from home. ITB has $2.49 billion in assets, and its top four holdings are D.R. Horton (DHI), Lennar Corp. (LEN), NVR (NVR) and PulteGroup (PHM). The ETF has a one-year return of 31.6%, three-year return of 16.4% and five-year return of 17.3%, with an expense ratio of 0.42%.
Financial Select Sector SPDR ETF (XLF)
The Financial Select Sector SPDR ETF could be a good asset for long-term investors, Blonski says. Banks and other financial institutions will improve their profit margins over the next five years. “The stocks in the ETF have been getting killed, but these companies have relative value,” he says. “These companies have been discounted so much and have not recovered yet. They will not stay beat up forever.” XLF reached a low of $17.49 in March, but is now trading at around $25, still below its 52-week high of $31.38. The five-year return is 7.69%, while the 10-year return is 9.54%. Its expense ratio is 0.13%. The ETF holds blue-chip companies such as Berkshire Hathaway (BRK.B), JPMorgan Chase (JPM) and Bank of America (BAC). “Financials are probably the cheapest cyclical sector left, especially banks, and will likely outperform if 10-year Treasury yields rise,” Gunzberg says.
VanEck Vectors Video Gaming and eSports ETF (ESPO)
Gaming and electronic sports, or esports, are an interesting thematic play for ETFs heading into the fourth quarter, says Matthew Timpane, a senior market strategist at Schaeffer’s, a Cincinnati-based investment research company. Gaming ETFs such as the VanEck Vectors Video Gaming and eSports ETF and the Global X Video Games & Esports ETF (HERO) will be a “big theme this year for the holidays with (pandemic) restrictions and people being forced to spend more time at home,” he says. “While there has been a huge run already with both the Sony PlayStation and Microsoft Xbox releasing their ninth-generation consoles this fall, this will likely only lead to a further uptick in sales growth for gaming companies.” ESPO’s top holdings include Nvidia Corp. (NVDA), Advanced Micro Devices (AMD) and Activision Blizzard (ATVI).
Six thematic ETFs for the rest of the year:
— Health Care Select Sector SPDR Fund (XLV)
— Invesco Water Resources ETF (PHO)
— Global X Cloud Computing ETF (CLOU)
— iShares U.S. Home Construction ETF (ITB)
— Financial Select Sector SPDR ETF (XLF)
— VanEck Vectors Video Gaming and eSports ETF (ESPO)
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